Solution Manual for Macroeconomics, 5th Edition

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BCS-1Suggested Solutions for BusinessCaseQuestions for ThoughtThis section offers suggested answers to theQuestions for Thoughtat the end of each chapter’s business case.CHAPTER 11.Explain how each of the twelve principles ofeconomics is illustrated in this case.Suggested Solution1.Principle 1: People must make choices becauseresources are scarce. Neither money nor time isunlimited; they are both scarce resources. Pricelinecaters to customers who have chosen to sacrifice someof their preferences about convenience or quality inorder to get a lower price.Principle2: The opportunity cost of an item—whatyou must give up in order to get it—is its true cost.The true cost of an empty airplane seat or an emptyhotel bed is the revenue the airline or hotel couldhave earned from the next best use of that seat orbed—namely,the revenue earned from a payingcustomer.Principle3: “How much” is a decision at the margin.How much more a customer is willing to pay for aticket to a destination depends upon how much timeand inconvenience is saved by purchasing the higherpriced ticket.Likewise,how much more a customer is willingto pay for a ticket purchased well in advance of histravel date depends upon how much more security hegains by advance planning rather than waiting to pur-chase. The same principle applies to decisions aboutthe quality and location of hotels, and so on.Principle4: People usually respond to incentives,exploiting opportunities to make themselves betteroff. Priceline was successful because its customers—travelers, airlines, and hotels—were exploiting opportu-nities to make themselves better off by using its services.Priceline also responded to incentives to make itself bet-ter off by expanding into new profitable markets such asEurope.Principle5: There are gains from trade. Travelers gainfrom using Priceline’s networks of hotels to find ahotel rather than doing the research themselves. Theygain from using Priceline’s services to book a flightrather than contacting each airline individually. Also,travelers gain by using the services of airlines andhotels, rather than transporting themselves or pitch-ing a tent overnight to sleep in. Hotels, particularlyin Europe, gain from using Priceline’s network ratherthan trying to contact potential customers directly.Principle6: Because people respond to incentives,markets move toward equilibrium. Expedia and Orbitzmoved into the online travel service industry in orderto exploit opportunities that had been pioneered byPriceline. In this way, the market for online travelservices will move toward equilibrium until thereare no more opportunities for new travel servicecompanies to exploit.Principle7: Resources should be used efficientlyto achieve society’s goals. Priceline exploitedanopportunity to use resources more efficiently. It isinefficient to have empty hotel rooms and airline seatsif someone is willing to pay some price to use them onshort notice.Principle8: Because people usually exploit gains fromtrade, markets usually lead to efficiency. It is ineffi-cient to have planes flying with empty seats and hotelswith unoccupied beds. Thus, introducing a market forthose items—which is what Priceline did—improvesefficiency.Principle9: When markets don’t achieve efficiency,government intervention can improve society’s welfare.It would have been inefficient to have major airlinesfail because of the public’s temporary fear of flying.Vast resources would have been wasted as pilots andsupport staff lost their jobs, planes were mothballed,necessary trips cancelled, and so on. It improved effi-ciency for the government to step in and temporarilyaid the airline industry so that it could survive thetemporary downturn.Principle10: One person’s spending is another person’sincome. In the aftermath of the attacks of September2001, as people stopped spending on items like travel,the income of airline workers was severely reduced.Principle11: Overall spending sometimes gets outof line with the economy’s productive capacity. Theoverall economy went into a slump after the attacks ofSeptember 2001 as the economy’s productive capacityexceeded its spending.Principle12: Government policies can change spend-ing. The $15 billion aid appropriation by Congress wasspent on stabilizing the airline industry and preventedmajor airline failures.

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